Some people, in offhand remarks, claim that investing is a numbers game. While this is not entirely true (as there are many qualitative aspects to investing as well), I would admit that numbers do pop up very frequently in the field of investing, such that a good grasp of numeracy would be a boon for the aspiring investor.
Numeracy is defined loosely as “the ability to understand and work with numbers”, and this involves both i) understanding what certain numbers and ratios mean, and also ii) being able to do calculations and computations involving numbers to achieve meaningful insights. I would actually add a third – having a common-sense approach to numbers which can prevent an investor from getting into trouble.
I mentioned the importance of learning accounting in a previous article, but that merely covers the business and conceptual portion of investing, to gain an understanding of what the financial statements entail.
If we step back and looked at investing from a broader view, the fact is that we see numbers all the time. Apart from financial statement analysis, there are also numbers involved in buying and selling shares, where we have to deal with liquidity and bid-ask spreads. In the area of portfolio management, investors deal with numbers too when it comes to sizing their positions, calculating their dividend yields and also knowing their gains or losses on their portfolio on an overall basis.
Numeracy is important for a basic understanding of ratios and percentages. A glance at a set of financial statements would show columns which feature the year-on-year percentage changes in revenue, operating profit and net profit. Getting a sense of how companies perform involves looking at the growth or decline in such percentages, and one can immediately get an impression of how strong or weak the company is.
Glancing further down the earnings release or annual report, the investor may also encounter financial and operational metrics which are stated in numbers, such as economic-value-added (EVA), the number of stores opened (for the retail sector), and production utilisation (for factories). Numeracy skills come in useful here for plotting the numbers in a spreadsheet to track how they have evolved over the years. The idea is to slowly build up one’s competence in looking at such numbers so that one becomes more sensitive to them as the years go by, thus accelerating the review process.
The Foolish Bottom Line
As can be seen, numeracy skills help an investor to become more aware and sensitive to key numbers and ratios used in investing. As he polishes this skill, he would become more efficient and effective in filtering out good companies from bad ones, and would also have a better inherent sense of whether to invest in a company or not.
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